Temperamental twitter tales of oil

Some news stories are a bit ridiculous. Apparently, a Cornell University research team has examined millions of Tweets and confirmed that we are happiest in the morning and in a bad mood by the end of a tough workday. Hmmm…. other than being a statement of the obvious, I’m scratching my chin on this one, because I know some people that are always in a bad mood, regardless of the time of day.

Anyway, in light of this deep, Ivy League insight on personal temperament, I tried to think of a Twitter experiment that would confirm the obvious as it relates to the mood of the oil markets. Personally I don’t use Twitter, so I had to revert to the Bloomberg wire as an old-school substitute.

Last Friday, the end of the third quarter, was ideal for browsing headlines. After a good cup of morning coffee that lifted my attitude, the screen flashed up a story on how oil prices were set to show their “largest quarterly decline in New York since the 2008 financial crisis,” with the obvious negative mood swing being attributed to, “signs of slowing growth in China, the U.S. and Germany….”

Price, which is the market’s mood, always follows swings in economic sentiment, which is why a barrel of WTI closed under $80 on Friday. I mentioned in last week’s column that China’s economy is especially important to watch, because its growth rate and size contributes to over 35% of the world’s new oil demand. In other words, if China’s economy slows down it’s a bad hair day from the start.

But there is one thing that isn’t so obvious: Over time, the growth of an industrializing country like China becomes less connected to oil, and that’s something that’s not necessarily being captured in the market’s mood.

In the early phases of an emerging economy there is a tight correlation between a percent of GDP and a percent of oil consumption. Visually, the relationship can be quantified by analyzing China’s numbers in Figure 1. Each data point represents a year’s level of economic activity (real GDP) and its corresponding annual average oil consumption (in millions of barrels per day). As the economy grows year-by-year toward the right of the chart, oil consumption rises upward in a strong linear pattern. Monitoring the rate of change, or the slope of the points in Figure 1, gives an indication of the sensitivity, or intensity, of China’s oil consumption to its economic activity.

Analyzing what’s going on entails some science and a bit of art. Between 1990 and 2006 (line A), China’s oil intensity has been tracking around 0.75, which means that for every 1.0% change in its GDP growth, oil consumption was changing by 0.75%. That’s typical of a rapidly industrializing economy, but the history of developing countries is such that the slope decreases over time, usually in noticeable kinks or “Break Points”. Fuel diversification and greater energy efficiency are the two principal mechanisms that force the slope down, almost always in response to unsustainable consumption practices.

So, it’s line B that’s more interesting. Since 2007 China’s oil-economy calculus has become noticeably less intense. Now tracking 0.6, it means that a percent of GDP growth in China is 15% to 20% less impactful on oil demand than it was only a few short years ago. That’s still a pretty high intensity, considering that most European countries, Japan, and even the United States are now at zero or less.

But the real point with respect to China, which is so influential to oil price, is that there are two dynamics at play: both GDP growth and oil intensity are feeling a downward tug. Although a “hard landing” doesn’t appear likely in China at the moment, there is increasing evidence that 9.0% per year expansion is very vulnerable. With respect to declining intensity, it’s important to recognize that there is no historical precedent for a country to become less energy efficient over time, nor is their any tendency to undo the diversification of its energy systems. In other words, the principal parameters that are driving oil consumption in China – economic growth and intensity – are as good as they get right now, and there are strong indications that both are retreating.

Let’s be clear that these are just moderating trends. Oil demand is not going away in China and she will continue to use more oil in the coming years, not less. However, the two related downtrends mean that growth volumes are not likely to be as much as the market thinks and by the time someone Tweets about it, it’s going to be too late to see the obvious. So in the future, oil markets seeking a better mood are going to have to subscribe to more Tweets on the supply side of the oil equation.

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